Startup, Venture Capital equity, ownership, Rule of Thumb, stock options
A rule of thumb for startups is to set aside a pool of stock options that equates to 10% of the company following its first round of funding. This employee stock option plan will be used as compensation for future employees, that is, employees beyond the founding team.
Startup, Valuation, Venture Capital angel, burn rate, employees, hire, Valuation, Venture Capital
A good rule of thumb for an appropriate start-up burn rate is about $100,000 per month. For example, a web-based startup should be able to operate for one year if they raise a $1 million dollar angel round. This will equate to approximately 3 founders at the time of the equity raise, to hiring 7 people for a total of 10 people at the end of 1 year. The cash will be burned on the salaries and operating expenses of the startup and should provide enough runway to eliminate some of the initial market and technical risks so that the startup can raise a venture round at a favorable valuation.
Business, Startup ASP, Average Selling Price, business model, Rule of Thumb, sales force, Start-up
A product or service needs to have an Average Selling Price (ASP) of at least $200,000 to justify a direct sales force. Anything less than $200k needs to be sold via partners, channels, or inside sales. This should be helpful in developing business models for start-up companies, particularly in the enterprise software space.
Private Equity, Startup, Valuation, Venture Capital Conflict of Interest, Inside, Investment Round, Outside, Rule of Thumb, Valuation
As a general rule, firms will only raise an inside investmetn round if they cannot raise an outside round. An inside round means that the entreprenuer only raises capital from the investors in the previous round. This situation raises a serious conflict of interest around the valuation of the round since there is not any objective 3rd party to set the new valuation.
Startup, Venture Capital Acquisition, IPO, Liquidity, Rule of Thumb
In recent years (following the bubble of the late 90′s) it has taken new ventures an average of 6.5 years to reach a profitable exit via a liquidity event (acquisition or IPO)
Startup, Venture Capital Capital, Cash Flow Positive, Financing, Rule of Thumb
On average start-up new ventures will require $68 million in financing to reach cash flow positive. This capital is typically raised over 4 rounds. Once the new venture reaches cash flow positive, in theory, it should be self-sufficient thus not requiring any further investment.
Legal, Startup, Venture Capital Legal, New Venture, Rule of Thumb, schedule, Shares, Start-up, Startup, Venture Capital, vesting
Legal, Startup, Venture Capital cliff, compensation, equity, investor, ROT, Rule of Thumb, schedule, stock, Venture Capital, vesting
A good rule of thumb regarding equity ownership in your company is to institute a vesting schedule on stock grants. This has numerous benefits the two primary being:
- Better terms than the vesting schedule a VC will impose on you…and they will impose a vesting schedule on you.
- Helps eliminate problems and costs associated with individuals leaving the firm with equity before a liquidity event.
The rule of thumb for vesting time horizon is a 1 year cliff followed by straightline monthly vesting.
Legal, Startup, Venture Capital compensation, equity, investor, ROT, Rule of Thumb, vesting
A good rule of thumb for a startup environment is to avoid “deferred” compensation. Any type of investor (bank, angel, friends and family, and especially venture capitalists) will view deferred compensation as a significant deterrant. Since deferred compensation has seniority over all other stakeholders, it adds a level of risk to their investment. A better way to compensate yourself is through paying yourself in equity through an earnout or vesting schedule.
Startup, Valuation, Venture Capital Rule of Thumb, Valuation, Venture Capital
Writing here as a Silicon Valley VC, I’m going to spill the beans on how valuation is really determined in practice. Quite simply put: “Valuation is a function of negotiating leverage and target amount of capital that a VC wants to invest — particularly for early-stage companies.” 1) In general terms, VCs target 20-30%+ ownership of a company. Why? It all boils down to ownership structure — VCs can’t take too much ownership of a startup, otherwise there’s not much incentive for the entrepreneurs to build something large. At the same time, VCs can’t take too little ownership, or else even a healthy exit of, say, a $200M acquisition doesn’t move the needle for the VC’s fund of $200-300M+. The typical baseline is that for a classic Series A, VCs will take 50% of the company. 2 VCs syndicating a deal (which is often a wise structure to allow for more pockets of $ around the table — especially important should the company need additional insider financing to get to the proper milestones to drive an increased valuation for the next outsider-priced round of funding) will want 25% each, and also call for an option pool of 20% or so to be created, leaving the founders with ~30% ownership. 2) Given the typical 50/50 split, the baseline expected amounts to “pre-money valuation = target amount to be raised” (e.g. $5M raise on $5M pre, $20M raise on $20M pre). This is where both negotiating leverage and the dirty secret of the VC industry kicks in… 3) Leverage is determined by how hot the deal is (e.g. how many VCs fighting to get into the deal), and how badly the company needs money. This is an odd one though, as it’s somewhat chicken and egg — as soon as a desperate startup that’s about to fold gets a term sheet from a “name brand” VC, all the other lemmings pop out of the wood work and start their mad frenzy to get into the deal, often resulting in a bidding war as each new would-be party crasher proposes a higher and higher pre-money valuation (e.g. going from “$5M raise on $5M pre” to $5M raise on $10M pre”). On the other hand, if the deal is regarded as “picked over” by all the VCs who have taken a look and passed, a VC who wants the deal can likely win the deal at an extremely punitive pre-money valuation, and even swing the ownership structure to 60%+ ownership for the VCs (e.g. $5M raise on $2.5M pre). 4) So here’s the wacky part: if you’ve been following along, you may have been thinking to yourself, “wait a minute — if pre-money valuation is pretty much tied to amount raised, then who determines the proper amount of capital to be raised?” Enter the screwed up dynamics of the VC industry, which has been suffering from a state of capital overhang — or in other words, “too much darned $ invested into VC funds since the bubble days!” Often, startups may only need, say, $5M to get to the milestones needed to raise the next round of funding at a markup in valuation. However, if a $500M-$1B fund needs to deploy $10-15M a shot per deal due to the large size of the fund, then the VCs will likely inflate the amount to be raised…and thus raising the pre-money valuation in the process. (And what entrepreneur would turn down more money offered to him or her at pretty much the same ownership dilution?) Strange, eh? Valuation in many cases therefore has nothing to do with inherent “value” of the company or operational achievements made to date — like the cause for all wars and pretty much the story of the human race, it’s pretty much “all about the Benjamins” as the rappers say.
[Note -- one subtle dynamic that most entrepreneurs don't realize upfront when increasingly large bags of $ are being dangled in front of them: yes, it's very tempting to take more money at the same ownership structure as a deal with a smaller amount of $ raised. However, the key to valuation is thinking about POST-money valuation, and not pre-money. Think of post-money valuation (which equals pre-money valuation + amount to be raised + any additional warrants or post-round option pool increases) as the hurdle you set for yourself to clear as the minimum pre-money valuation you need to get to for the next round. Case in point: you're raising your Series A, and you need $5M to build the product and get to the first $1M in revenue. You're playing in a reasonably hot space that's starting to get some buzz, so you get your first term sheet for $5M on $5M. Word gets out, and other VCs start doing drive-by diligence and lobbing in their competing offers. Next thing you know, you're staring at a $10M raise on a $15M pre! Fantastic, right? Higher pre-money valuation, more money in the bank, and even less dilution than the first offer! The unspoken risk, however, is that you've now set the bar for Series B pre-money valuation at a floor of $25M just to get a flat-round valuation. And since you're gunning for increased valuations over the previous round post-money valuation to minimize dilution, what that really means is that you need to hit a $35-40M+ pre-money valuation for Series B to minimize dilution to your stake. Let's say the $5M would've taken you to $1M in initial revenue, and with most VCs wanting to invest $5-10M per round, it'd be the perfect sweet spot for a Series B of, say, a $15M raise on $20M+ pre -- a reasonable markup from the Series A post-money of $10M. However, it's likely the additional $5M raised in a $10M Series A funding would take you to perhaps $2-3M in revenue -- a point highly unlikely to earn you a $40M premoney (unless your space in general is the hot fad of the moment). The bottom line: there is no free lunch, and the illusion of a higher pre-money valuation accompanied by an inappropriately large amount of capital raised often results in an unpractically high post-money to overcome for the next round of funding. The fortune-cookie version of this takeaway is the following: "Confucious say fixating on pre-money is like standing too close to work of art -- missing bigger picture! Only post-money matters."] (man, I hope I don’t get whacked for revealing the secret!)